There are multiple considerations to be made when valuing a privately-held company and the assessment of the many moving parts.
The valuation of privately-held firms, including those in the AEC industry, will usually involve discounting to arrive at a concluded value of the subject interest. For those of you who have been through the valuation process in the past, you are at least familiar with the terminology; for those of you who have not, I thought a primer might be in order.
To place a value conclusion on a privately-held business interest, we must determine the level at which the valuation will be done – a control interest basis or a minority interest basis. An owner of a 51 percent or more interest is considered a “control” owner and a holder of 49 percent or less is considered a “minority” owner. In the context of fair market value, the levels of these two types of owners are significantly different. It would be easy to assume that the value of a minority interest in a privately-held firm is equivalent to the pro-rata value of a 100 percent interest, but that is not the case. Issues of control and marketability at the minority interest level must be taken into account.
The various approaches and methodologies used in valuation will drive whether or not discounts are applicable to the subject interest in an appraisal.
- Asset approach. Under an asset approach, no individual shareholder owns the corporation’s assets at the individual level; shareholders with a majority position and voting control have the ability to control the corporation and the accumulation or disposition of the assets. Therefore, the control shareholders have access to the equity in the assets and asset-based methodologies produce values at the control level.
- Income approach. Depending upon the appraiser’s decision as to the level of normalizing adjustments to the financial statements, income approach methodologies can produce a value indication at the control or minority interest level. If “control” normalizing adjustments are made, the value indication is at the control level. The opposite is true if the only normalizing adjustments made are those applicable to what a minority interest holder could affect.
- Market approach. The transaction data used in a market approach methodology will have a direct correlation to the level of value produced. In a majority of our engagements, we use privately-held company transaction data, which is representative of a control interest.
With a brief review of the approaches and the levels of value produced, let’s get to the discounts:
- Discount for lack of control. A discount for a minority interest is taken from a control level value indication to account for the lack of control associated with a minority shareholder. Studies suggest the size of the minority interest discount are based upon control premium studies, resulting in average implied discounts of about 23 percent in today’s environment. To properly develop an appropriate discount for a subject interest, an appraiser should consider several factors that could increase or decrease the discount. Factors include non-voting interests, extreme lack of consideration of minority shareholders, an interest insufficient to stop corporate action or elect a director, the existence of put rights and the presence of enough minority owners sufficient to block certain actions or have meaningful input on elections of directors.
- Discount for lack of marketability. A discount for a lack of marketability is meant to account for the lack of liquidity (or marketability) of stock that is not traded on a public exchange. A market of readily willing buyers and sellers exists for publicly traded stocks, the market is able to consummate transactions in a short period of time and proceeds are usually available within a few business days. The public market is contrasted by a small market existing for closely-held shares that are economically impaired due to the lack of access to an active market for those shares. Empirical evidence exists in studies of discounts on sales of restricted shares of publicly traded companies and discounts on sales of closely-held shares compared to prices of subsequent IPO offerings of the same company’s shares. In all, the studies result in a range of discounts from about 10 percent to more than 35 percent. As with the DLOC, multiple factors can have an impact on the appropriate discount for a subject interest. Factors include transfer rights, dividends or the lack thereof, the prospect of selling the firm, the existence of a market for the block of shares being valued, put rights, the existence of a buy-sell agreement, stability of earnings, etc.
There are multiple considerations to be made when valuing a privately-held company and the assessment of the many moving parts. What shareholders should take away from this brief discussion is that every decision made within a firm, from financial to corporate governance, will have an implication on a final value conclusion.
Tracey Eaves, MBA, CBA, CVA, BCA, CMEA is a member of the valuation consulting team at Zweig Group. She has been valuing privately held company interests for more than 18 years. Contact Tracey at email@example.com or directly at 505.258.8821.